10. Case Studies

The following case studies are based on
actual negotiations involving Pacific Rim Business Brokers.The names and numbers have been altered slightly to
protect the innocent (and guilty).

Case Study 1

Mr and Mrs Johnson owned a well
presented freehold motel in the Central West of New South Wales.The motel occupancy was around 28%.The average occupancy rate for the town was 52%.

The vendors listed the motel for $1.2
million.The net
profit was $120,000, a return on investment of 10%.At the time the prevailing rate of return was around 14%,
so the motel appeared to be about $350,000 overpriced.

I sent brief details of the motel to my
database of buyers, and 54 requested complete details.When they received details of the motel, 53 of the 54
potential purchasers suggested the motel was overpriced and they
would only be interested if the price was dropped to around
$850,000 (a 14.1% return).

I suggested they look closer at the
business.There had
to be a reason why a well presented 3½
star motel was trading 34 percentage points below the town
average.In fact,
there were at least five reasons.

The vendors were elderly and very
tired.They did
not have the energy to promote their business and were just
“ticking along”.

The motel vendors took a lot of breaks.For 20 weeks a year the motel was run by a relief
manager.The
owners didn’t ask much of the manager, and there was
anecdotal evidence that he displayed the no vacancy sign
around 6pm.

There was no debt on the motel.The vendors made a comfortable living, but didn’t
have the motivating threat of a bank on their backs.

The motel did not have a website.There were a few mentions of the property in the
local tourism site, but that was about it.

The motel was not linked to any
internet booking sites.Potential guests who searched for a place to stay on
Wotif, Quick Beds or Need it Now would not have found this
property.

One of the 54 buyers agreed with my
assessment.Mr and
Mrs Fergusson felt they could turn the motel into a thriving
business that in no time would be worth more than the asking
price.However,
because they were the only potential purchasers with enough
confidence to turn the business around, they were also the only
parties who physically inspected the motel.

The Fergusson’s made an offer of $1
million.That was a
12% return on investment, and still much more than prevailing
market rates of return.As they were the only buyers the vendors felt they had to
accept the offer.

Between exchange and settlement Mr and Mrs
Fergusson organised a cutting edge website complete with booking
engine, and signed up to all the internet motel booking
companies.

Within 6 months of settlement their motel
slightly surpassed the town average occupancy rate and within a
year it was running at 56%.

By increasing the occupancy rate from 28%
to 56% they increased profits by 100% to $240,000.They now had a business with a 24% return on investment.

The Fergusson’s continued to improve the
motel and sold it a year later for $2,100,000 on a profit of
$294,000 (14%).

They made a capital gain before stamp duty
and legal fees of 110% because they analysed the reason for the
motel’s poor performance and set about correcting it.

No doubt some of the other buyers who
rejected the motel as overpriced went on to buy a motel at the
prevailing market price with a strong track record of steady
profits based on average occupancy rates.But is doubtful whether any of them made a 110% capital
gain in 24 months.

Case Study 2

The vendors of a coastal motel called to
say they wanted to sell their freehold property for $2 million.It was netting $360,000, so with an 18% return this was a
definite bargain.

It was the start of the GFC, and the
vendors were aware that buyers were scarce.

They emailed their trading figures, and I
could see that the motel was offering an 18% return, but only if
all the add backs were accepted.

Their add backs included interest,
depreciation and their own wages – add backs generally accepted
in the industry.But
they also included about 15 other items such as breakfast cook,
25% of the repairs and maintenance, non performing advertising,
accountancy fees (which they felt were too high) and various
other expenses.

If all 15 items were not accepted the net
profit would have dropped by $20,000 to $340,000 - still a very
acceptable 17% return on investment.

I found one interested buyer (buyers were
indeed scarce at this time) and he immediately questioned each
of the add backs.
The vendor had a good explanations, but many of them could be
categorised as “in the grey area”.

Then began a long email correspondence
between Mr Robertson, the potential purchaser, and the vendors.Generally all correspondence goes through the agent, but
Mr Robertson seemed determined to tell the vendors directly that
their add backs and grasp of accountancy were at best dubious.

I was copied into the emails, and saw that
whatever relationship there was between the buyer and seller, it
was on very shaky ground.Mr Robertson didn’t go as far as telling the vendors they
were presenting false figures, but he went very close.

A couple of times I suggested that even if
the full $20,000 of add backs were disallowed the motel was
still selling for a return on investment of 17%, well above the
market rate of 14%.
Mr Robertson disagreed.

He and his accountant thoroughly checked
the motel figures and agreed they were correct, but refused to
accept $20,000 of add backs.He submitted an offer of $1,888,888, exactly an 18%
return on the net profit of $340,000 (which excluded the $20,000
of add backs).

The vendors said they would consider the
offer, but made it plain they were not happy with Mr Robertson
and his 15 emails.

While they were considering the offer a
second buyer inspected the motel.Mr Gilbertson was just back from overseas, received
details of the motel from me and arranged an inspection three
days later.

The inspection went well, and Mr Gilbertson
submitted an offer of $1.8 million.I told him there was a higher offer on the table, but I
would (as obliged by legislation) submit the offer.I asked him if he was concerned about the add backs.He said he disagreed with most of them, but at that price
he didn’t care.He
wasn’t going to raise the matter with the vendors.

As you can probably guess Mr Gilbertson’s
$1.8 million offer was accepted and he proceeded to exchange and
settle contracts.

So why didn’t the vendors accept the higher
offer of $1.88 million.

Conventional economics suggests that
rational business people always try to maximize their profits.Behavioural economics, which is much more interesting,
suggests that there are many more processes at work.

The vendors were angered by the tone of Mr
Robertson’s emails.
They felt they were offering their property at a bargain price
and that both parties should agree to disagree about the $20,000
of add backs.They
also felt Mt Robertson was more interested in giving them a
lesson in accounting than buying a motel.

Basically, they were sick of Mr Robertson,
and when Mr Gilbertson appeared on the scene they had the
opportunity to show Mr Robertson what they thought of him.

The winner, of course, was Mr Gilbertson.He purchased the motel for a return on investment of
either an 18.89% or 20%, depending on whether or not the add
backs were accepted.

Three years later he sold it for $2.85
million, a 14% return on the net profit of $400,000 (with no add
backs).

Case Study 3

A young couple was interested in purchasing
a motel and had discussed the matter with their bank.
The bank told them they
could be financed if they purchased a motel up to $800,000.Naturally, finance was dependent upon a valuation and
compliance with all the bank’s lending policies.

They found a motel that suited them and
asked the vendor if they could enter into a contract with
settlement conditional upon the obtaining of bank finance.span style="mso-spacerun:yes">
The bank had briefed a valuer who was ready to inspect
the motel within five days, and they were told the loan should
be ready in 21 days.

The standard contract has a 42 day
settlement period, so they felt they had plenty of time for
formal approval of the loan.

The vendors’ solicitor prepared a contract
with settlement conditional upon the obtaining of bank finance
and sent it to the purchasers’ solicitor.Then things started to go astray.

The purchasers’ solicitor strongly advised
his clients not to sign. He
said a contract conditional upon finance was not worth the paper
it was written on.
He advised his clients to secure their finance first, then sign
contracts.

Being young and naïve, the purchasers
thought solicitors were always right.They told the vendors they would exchange after obtaining
a formal offer of finance, then paid the valuer $4,500 to value
the motel.

The vendors were a bit put out.They felt they were the ones taking the risk by entering
into a subject to finance contract.They felt they were giving the young buyers a chance and
were risking losing an alternate buyer during the “subject to
finance” period.

The contract their solicitor had prepared
was watertight.
There was no way the purchasers would lose their deposit if they
did not obtain finance.They really had nothing to lose.

The purchasers told the vendors they had to
accept their solicitor’s advice.“That is what we pay him for.”

Three weeks later they rang the vendors to
tell them that they now had formal approval from the bank for
their finance.The
vendors congratulated them, but told them they had exchanged
contracts with another party.

The vendors might be considered a bit
heartless, but to their minds they had a hand shake deal and had
agreed to take a small risk to help the young couple.They didn’t sell the motel for any more money, but they
did sell it to a business person who made his own decisions.

Case Study 4

A very keen motel buyer
was seeking a freehold property priced to $1,000,000 offering at
least a 14% return on investment.We sent details of a motel priced at $1.2M offering an
11.5% return on investment ($140,000 net).

The buyer liked
everything about the motel except the price and the return.We encouraged him to make an offer but the buyer said, “I
don’t want to insult the vendor.”

A month later another
buyer offered the vendor $950,000 and the vendor, realising that
at $1.2M his motel would never sell, accepted.

After contracts were
exchanged and settled the original buyer called and asked what
happened to the motel.We told him it had sold for $950,000 – the sale was on
the public record.

The buyer was quite
upset.“I would have
offered one million,” he said.

If he had both he and
the vendor would have been very happy.The fact that he didn’t want to offend the vendor meant
that he had missed out on a motel he really liked, and the
vendor had missed out on an extra $50,000.